Analyze your competitive environment:

To craft good strategy and improve upon our performance, we need to understand the competitive environment our current firm or institution or product currently exists in. The five forces framework developed by Michael Porter is the most widely known tool for analyzing the competitive environment, which helps in explaining how forces in the competitive environment shape strategies and affect performance. The framework shown in below figure suggests that there are competitive forces other than direct rivals which shape up the competitive environment.

However, these five forces are not independent of each other. Pressures from one direction can trigger off changes in another which is capable of shifting sources of competition. Michael E. Porter advocates that a structural analysis of industry should be made so that a firm is in a better position to identify its strengths and weaknesses. The model consist of five competitive forces:

1. Threat of new entrants: Entry of a firm in a market is seen as a threat to the established firms in the market. The competitive position of the established firms is affected because the entrants may add new production capacity or it may affect their market shares. They may also bring additional resources with them which may force the existing firms to invest more than what was not required before. As the situation becomes difficult (sometimes threatening) for the existing firms, they resort to raising barriers. These barriers are intended to discourage new entrants and this may be done in an organization in some of these ways:
  a. Economies of scale
  b. Learning of experience effect
  c. Cost disadvantage independent of scale
  d. Brand benefits
  e. Capital requirements
  f. Switching costs
  g. Access to distribution channel
  h. Anticipated growth

2. Bargaining power of suppliers: If the number of suppliers is few, they enjoy the monopoly situation and their profits increases. Also, when the switching cost of the buyer is high, then also, the suppliers stand on beneficiary position. Supplier’s bargaining power would normally depend upon:
  a. Importance of the buyer to the supplier group
  b. Importance of the supplier’s product to buyers
  c. Greater concentration among suppliers than among buyers
  d. High switching costs for buyers
  e. Credible threat of forward integration by suppliers

3. Bargaining power of buyers: It refers to the ability of the industry’s buyers (customers) to force the industry to reduce the price or even to supply something more at same price. The bargaining power of buyers depend on:
  a. Undifferentiated or standard supplies
  b. Customer’s price sensitivity
  c. Accurate information about the cost structure of suppliers
  d. Greater concentration in buyer’s industry than in supplier’s industry and relatively large volume purchase
  e. Credible threat of backward integration by buyers

4. Threat of substitutes: Identifying substitute product is a matter of searching for other products that can perform the same function as the product of the industry. The competitive pressure which any industry faces depends primarily on:
  a. Whether the substitutes available are attractively priced
  b. Whether buyers view substitutes available as satisfactory in terms of their quality and performance
  c. How easily buyers can switch to substitutes

5. Competitive Rivalry: Rivalry among the existing competitors takes form of price competition, advertisement battles, product differentiation, increased customer service etc. Rivalry occurs because one or more competitors either feel the pressure or see the opportunities to improve. The factors of rivalry are
  a. The stability of environment
  b. The life expectancy of competitive advantage
  c. Characteristics of the strategies pursued by competitors.